ESG has outgrown a single label — but we’re stuck with it

Increasing concerns about greenwashing within ESG have led to suggestions that the term should scrapped or have its definition significantly narrowed. However, the world is complex, and aspirations around covering environmental, social and governance issues won’t benefit from ignoring that complexity, leading rather to short-term gain but long-term pain.

By Blake Goud, CEO, RFI Foundation

• ESG is facing a crisis of confidence driven by marketeers ‘hijacking’ it and conflating ESG & impact
• The backlash against over-promising & under-delivering has provoked a search for narrower, more limited definitions to redefine and replace ‘ESG’
• Replacing or restricting ‘ESG’ offers appealing simplicity but creates more issues than it solves, and adding definition within ESG rather than scrapping it is a better path for a maturing market

Judging from media coverage, environmental, social & governance (ESG) is facing a crisis of confidence. And it’s true that there has been an uptick in claims made that haven’t matched with expectations because a lack of uniform terminology has opened up room for what Steve Varley, Global Vice Chair of Sustainability at EY, described as ESG being “hijacked” by marketeers who conflated ESG and impact.

A report issued by EY, “The Emerging Sustainability Information Ecosystem,” walks through several areas for improvement including disaggregating ESG ratings, understanding different data user types, improving ability for assurance, and harmonizing taxonomies. These are sensible elements but are long-term solutions to a present-day problem.

Other solutions have been proposed recently, such as equating the ‘E’ solely with emissions, but this is undesirable in the face of increasing concern about other planetary boundary issues like biodiversity or natural capital. These feed into cross-cutting issues such as climate change, but don’t benefit from the same solutions or face the same measurement challenges as those directly posed by companies’ greenhouse gas emissions.

There is a recognition now that single metrics for ESG issues have achieved broad awareness, which in turn has unearthed challenges that were clear but perhaps not material when ESG was a ‘niche’. Its growth and the growing materiality of the challenges that its complexity brings do not mean it is on the verge of diminishing in importance. Efforts to find single indicator replacements such as focusing solely on emissions (presumably at the corporate level) will create as many problems as they solve.

For example, is it desirable to whitewash equity issues around who has benefited most from historical emissions? Is it desirable to omit how emissions sources have migrated geographically in the past and how that impacts who will bear the ultimate cost of reductions, where quantification is prized above all else? How you answer these questions will impact your assessment of how appropriate a single metric of emissions for the “E” in ESG is working.

Last month, I wrote an article cautioning the Islamic finance sector as it works to integrate ESG considerations with its foundational Shariah principles. The risk that Islamic finance faces from the lack of consistent terminology in ESG and more broadly across responsible finance is that different activities could be misidentified in terms of how they relate to various categories within responsible finance.

Ethically oriented, exclusions-based screens are adopted regardless of financial impact. Other foundational screens within Islamic finance to avoid interest-based financing serve a values-based purpose for Islamic finance but also have utility from a purely financial perspective. On top of these screens, Islamic finance can overlay consideration of ESG issues and outcomes for the same variety of reasons as others do.

It is easy to say that Islamic finance is consistent with, or shares commonalities with, other parts of responsible finance. But that does not give an observer any better idea of how to evaluate the particular claims made in relation to one financial product or by one financial institution; it is only by narrowing definitions so they can be linked with a clear and concrete action that makes it possible to view, review and evaluate consistence between a claim and reality. The same challenge confronts someone trying to evaluate the wide variety of ESG claims.

Trying to replace ‘ESG’ or any of its constituents with a single metric or topic will just reignite new conflict about what should replace it. It will reinforce inequities created by divergent access to capital based on availability and perceived quality of data. The flaws will be transformed from greenwashing to attach a label for marketing gain to one where a single feature will define relevance, making the fight about what’s in and what’s out all the more intense.

There’s not an easy answer for the new challenges that ESG has received since it’s become mainstream. Many of the flaws and shortcomings that are taken to be previewing its downfall have been well known and the subject of a lot of effort to remedy in recent years. And even if there is some muddling through in the meantime as global and regional strategies develop, those who go in search of different facets of ESG will develop a better understanding of what they want and don’t want, with the evaluation tools to match.

For better or worse, the world is a complex place that is difficult to capture in one dimension, especially when covering ground as wide as environmental, social and governance issues. The past experience of lumping them together under a single acronym, and the unfortunate consequence of creating reliance on single point estimates for “ESG” for companies, was to find a large enough group with common interests.

That group of ESG, and broader when including other elements of responsible finance, has now outgrown a single label, but will take time before all of the subsidiary constituents build enough structure to link them back into an easy-to-use bigger whole. In the meantime — and possibly in perpetuity — we’ll all have to get used to qualifying our use of ESG with the issue, approach and metrics we use to evaluate it.

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